Charity begins at home – donate to charity and reduce your inheritance tax
New rules to Inheritance Tax (IHT) which came into force on 6th April 2012 mean that you can reduce the amount of inheritance tax that will be payable on your will by making a charitable donation. This change has been somewhat overshadowed by the reduction to the amount of income tax relief available on annual gifts to charity.
What are the rules?
Leaving 10% or more of your net estate as a gift to one or more registered charities will reduce the rate at which you are taxed on your estate under new rules issued by HMRC. If your estate is worth over £325,000 when you die inheritance tax is usually payable at a rate of 40%. However by making a 10% donation inheritance tax due will be paid at a reduced rate of 36%, rather than the standard rate of 40%.
A simple example
In a straightforward case an individual with an estate worth £525,000 and with the nil rate band of £325,000 available would need to leave £20,000 to charity under his will to qualify for the reduced rate of inheritance tax – 10% of (£525,000 less £325,000) = £20,000.
Gross values | Tax rate | Tax | ||
£ | £ | £ | ||
| Estate value | 525,000 | |||
| Tax free allowance | (325,000) | |||
| Taxable estate | 200,000 | 40% | 80,000 | |
| Charitable donation | (20,000) | |||
| Revised taxable estate | 180,000 | 36% | 64,800 | |
| Tax saving | 15,200 | |||
| Charitable donation | 20,000 | |||
| Tax saving from donation | (15,200) | |||
| Net cost to taxpayer | 4,800 | |||
| Effective tax relief on donation | 76% |
Is it worth it?
This is good news for charities and for taxpayers. If you are contemplating leaving a substantial legacy to charity in any event, then making sure that you satisfy the conditions to obtain the new relief may well benefit you and the charity – in fact this is the most tax efficient way that there is of making a charitable donation.
Even if the donation in your will doesn’t pass the 10% test when you die, the beneficiaries of your estate can arrange an ‘Instrument of Variation’ to make or increase a donation to charity. Doing so may mean that your estate can then qualify to pay the reduced rate of inheritance tax.
The calculation of the net value of an estate can be complex and it is not possible to ascertain during your lifetime. HMRC has therefore provided an example of the wording of a clause that can be included in a will to ensure that it will always meet the 10% test.
